Delaying cuts may work in OPEC's favor

April 21, 2003
Has the Organization of Petroleum Exporting Countries done its job too well?

Has the Organization of Petroleum Exporting Countries done its job too well?

Some key figures in the organization seem to think so, and the result is likely to be a return to official quota levels at an extraordinary meeting OPEC has scheduled, tentatively, for Apr. 24 in Vienna.

Not everyone agrees with that view, however, and if OPEC does its job too well again, then oil prices could finish the year closer to $30/bbl than to $20/bbl.

Fear of a glut

OPEC called for the special meeting to address a steep drop in oil prices that, counterintuitively, began well before a US-led war on Iraq got under way. That's counterintuitive because the preceding surge in oil prices to almost $40/bbl had incorporated a premium representing fears over the loss of oil supply from such a war. It was almost as if the steely resolve of the US and UK in demanding the disarmament of Iraq by itself was enough to dissolve those fears.

And oil prices dissolved along with those fears, plunging by almost 30% since mid-March. Accordingly, some analysts see a production cut as unavoidable.

"OPEC's current production rate is creating a tidal wave of crude oil that cannot all be absorbed by current and even rising crude oil demand," said Aaron Brady, senior analyst with Boston-based Energy Security Analysis Inc.

ESAI noted that, with Venezuelan and Nigerian production recovering, "the long-expected overhang of crude is starting to show up in US inventoriesU"

There is so much crude available during the seasonally slack second quarter, the consensus goes, that Iraqi supplies could remain off the market for several more months without threatening the global supply-demand balance.

Fresh fears of a possible oil glut prompted OPEC's call for a meeting, whose final date was still unclear at presstime. Alternative dates were put forth, including an early May date for the meeting reportedly promoted by Saudi Arabia. The Saudis, it would seem, want any cut in output to be delayed to June. That also might seem counterintuitive. It is mostly Saudi crude on the water, either en route to market or strategically placed in floating storage as a backstop during the crisis. It is also mostly Saudi overproduction that has offset the outages from Iraq, Venezuela, and Nigeria. So the Saudis would bear the greatest exposure to declining prices. Why isn't the kingdom lobbying for cuts soon then?

Timing's everything

For one thing, the Saudis—who this year bumped production to 9.5 million b/d from 8 million b/d—might not be in such a big hurry to cede market share back to Russia and others again.

But, more importantly, the Saudis might be heeding the projections of some economists who see a recession looming in the second half. A slide in energy prices might be just the thing to head off that eventuality. Lower oil prices have the double benefit of improving consumer economies while giving non-OPEC exporters pause to rethink expansion plans.

Not everyone believes that production cuts are needed now.

The International Energy Agency, for one, sees no reason for a rush to cut output. In its April monthly market report, IEA pointed to the extremely low levels of global oil stocks as reason enough to sustain production at current levels.

Delaying cuts to June also allows OPEC more time to gauge the timing and scope of the return of Iraqi oil to the market. It also enables OPEC to better assess prospects for demand recovery with the onset of the summer driving season (not to mention the stimulus that lower fuel prices gives to demand recovery). Refiners anticipating lower oil prices in the near term are holding off buying extra crude; a premature surge of stockbuilding might give a mistaken impression that underlying demand is greater than reality suggests.

So whenever OPEC meets in the weeks ahead, don't be surprised if the end result is a reaffirmation of existing but—as of February—ignored quotas. Then watch the Saudis ignore their own quota until Russia blinks again.

However, prospects of fresh crises loom on the horizon. The aftermath of an Apr. 16 election in Nigeria could be a civil war in that already strife-torn nation. Civil war could also be the outcome of an August referendum on the fate of Venezuelan President Hugo Chávez's regime.

The market might need that extra crude after all.

(Online Apr. 11, 2003; author's e-mail: [email protected])